Negative list, positive news

Expanding the service tax net is overdue

For years, economists did not know how to think about services. The tertiary sector of the economy was an afterthought for many early economists, and that caused a bias in economic theory and policy that lasts to this day. India’s high economic growth rates of the past few years have come on the back of sustained service sector growth. But this should not be seen as a completely new phenomenon. In fact, the productivity gap between developed countries and India in services has been consistently smaller than in other sectors for almost a century. Today, services contribute the majority of national income, but only a tiny fraction – 8.7 per cent – of central taxes. This is not a state of affairs that can be allowed to continue. The goods and services tax, or GST, has long been planned to rationalise and simplify the tax system. Yet its introduction continues to be stalled, largely for political reasons. It is particularly difficult to introduce, since it requires a constitutional amendment; some activities are under the purview of state governments, and are taxed by them in various ways. For a unified GST, thus, the states’ consent is a must. Not only have some state governments found it politically convenient to block the GST, but the service sectors that the state controls – entertainment, hospitality, construction, transport, gambling – are areas where the patronage that oils local politics flows freely. The political resistance at all levels to rationalising government oversight and taxation of these sectors is thus immense.

It is possible that the Centre has finally found a way around this problem. So far, only 125 service industries were being taxed, a tiny proportion of the overall economy. Positive lists – which indicate which sectors can be taxed – have that disadvantage. According to reports, the Centre will replace a positive list with a negative list, of service sectors not open to central taxation; all others will have to start paying tax. In essence, this appears to anticipate what the GST will eventually require, while postponing the necessary but complicated discussion of what happens to sectors already being taxed by the states under different heads. The idea is to sharply ramp up tax collections in such a way that, first, the introduction of the GST is made easier and, second, the Budget addresses India’s yawning fiscal deficit.

Naturally, the introduction of service taxes needs to be carefully managed. Service sector enterprises are typically lighter, with less overheads. Too much paperwork will sink many. Methods must be found to minimise the compliance burden, which will help expand the tax net. Internal discussion papers of the ministry of finance have suggested methods — for example, a uniform excise/service tax return, administered by the same department. The long-term blind spot among economists and policy analysts about services meant that services were not taxed till the Budget of 1994-95. India has not completely made up for this late start. Widening the service tax net, together with the rollback of the post-financial crisis reduction in tax rates, will help India’s much- needed fiscal consolidation.